2008-07-30 02:52:14
Don't Get Married to a Stock
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The most valuable piece of advice that I ever received when it came to trading was this: "Don't get married to a stock".
This advice doesn't just apply to trading - it applies to investing in general.
I have seen way too many people incinerate their portfolios because they refused to cut ties with a company. They bought a stock, and just wouldn't sell it, for a wide variety of different reasons. They didn't want to admit that they were wrong. They had invested too much money in the stock, and refused to take a loss. They were initially attracted to the company for some reason, but ignored all of the warning signs that maybe the company wasn't such a good investment after all.
Let's say that you invest in a company that is hoping to bring a new cancer drug to market. You are really excited about this drug, and think that it could be a blockbuster. You buy a large chunk of stock at $20.
The company doesn't appear to be making any progress, and as the years go by, more and more blemishes start to appear. The drug is not performing well in trials. The company loses one of their big partners. Insiders are dumping shares. Analysts are starting to question the company and are dropping their price targets.
Too many people make the mistake of going down with the ship in this case. They ignore all of the bad news and all of the warning signs, and they refuse to objectively re-evaluate the company every so often, which is crucial if you are planning on becoming a successful trader or investor.
People sometimes believe that "buy and hold" means that you simply hold onto a stock forever, no matter how its fortunes are changing. This is ridiculous. There is nothing wrong with buying and holding strong companies for the long-haul. However, you must constantly scrutinize the companies that you are investing in. Do you think that Warren Buffett just ignores the changing circumstances of the companies that he owns because he is a "buy and hold" type of investor? Of course not. Buffett is more than willing to dump companies that are disappointing him. Buffett cuts ties with companies every year that once held a place in his portfolio. He only continues to hold companies that he still feels strongly about, but only after re-evaluating the long-term prospects of a company every quarter.
Being able to cut losing stocks from your portfolio is a major key to your long-term success. It's generally never a good idea to "double" up a position just because the stock has fallen in price. You need to ask yourself the tough questions if a stock that you own has dropped noticeably. Has the underlying business of the company changed? Are the long-term prospects of the company the same? If I didn't own any shares of the company, would adding the stock to my portfolio interest me?
Stocks can trade up and down based on reasons that are separate from the actual company itself. Maybe the stock market is really weak. Maybe a major competitor to the company that you own was just involved in a major scandal, and it has taken down the shares of every company in the industry. Just because a stock trades lower, this doesn't mean that you should immediately be looking to sell. Just re-evaluate your positions every so often, and ask yourself if you still feel comfortable owning the company. Objectively evaluating the stocks in your portfolio (and being willing to sell the companies that you no longer feel strongly about) is crucial towards outperforming the market in the long-term.
I've seen way too many people who crashed and burned because they were unable to dump the shares of companies that no longer deserved a place in their portfolio. That is "getting married to a stock", and it's a surefire way to blow up your portfolio.
Filed under: Stock Market Education | General Knowledge
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